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Despite Its High P/E Ratio, Is Ryman Healthcare Limited (NZSE:RYM) Still Undervalued?

Simply Wall St

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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Ryman Healthcare Limited's (NZSE:RYM) P/E ratio and reflect on what it tells us about the company's share price. Ryman Healthcare has a price to earnings ratio of 20.14, based on the last twelve months. In other words, at today's prices, investors are paying NZ$20.14 for every NZ$1 in prior year profit.

See our latest analysis for Ryman Healthcare

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Ryman Healthcare:

P/E of 20.14 = NZ$13.13 ÷ NZ$0.65 (Based on the year to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Does Ryman Healthcare's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that Ryman Healthcare has a higher P/E than the average (10.6) P/E for companies in the healthcare industry.

NZSE:RYM Price Estimation Relative to Market, July 19th 2019

Ryman Healthcare's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Ryman Healthcare's earnings per share fell by 16% in the last twelve months. But it has grown its earnings per share by 11% per year over the last five years.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

Ryman Healthcare's Balance Sheet

Ryman Healthcare's net debt is 21% of its market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.

The Verdict On Ryman Healthcare's P/E Ratio

Ryman Healthcare trades on a P/E ratio of 20.1, which is above its market average of 17.8. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market.

When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine.' So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Ryman Healthcare may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.